Macro Man

As Macro Man referred to his progeny as his Macro boys, so Team Macro Man also have their own pack of brats. Who we will now on refer to as the Macro Minors. We were rather impressed when one of said Macro Minors, with perfectly topical timing (and also possibly an eye on the Frieze Art Fair), created this (click to enlarge):

TMM can’t help but notice that with FX moves like this all reasonable expectations or predictions of price levels makes discussing commodity target prices or inflation pretty surreal. It’s a mathematical fact that if the dollar goes to zero then silver in dollars goes to infinity and for the meantime the dollar debasement theme song appears to be Primal Scream's "Don't Fight It, Feel It".



As one astute market observer pointed out in a recent Bloomberg chat “it's like teenagers with a bottle of vodka in the park”. Quite. Despite all the fun of playing this game, certain members of TMM are having a recurring dream where they are on the train on the way to school and fall asleep. When they wake up they are at the last stop and the train is full of Terminators and you are John Connor.


Having played some of the spivvier metals some of TMM are taking their cash off the table since these charts look awfully CTA heavy. Similarly the price action in some previously dormant gold names gives us pause: sure it was a value proposition a month ago, but 40% in a month? Come on.


So if dollar debasement/long gold and precious metals feel a bit crowded where do you go? The problem is that the “lean against Asian Central Banks” trade has run really hard and the legislative action has already ratcheted up. Thailand has imposed taxes on local FX government bonds’ income payments, and look at the chart below: its as if everyone woke up post the euro crisis and decided to load the boat on Asian carry. Indonesian 20 year, Thai 20 year and the Asia Dividend yield index from ze Germans have all done exactly the same thing. Returns that haven’t been realized in FX have been made on yield compression, big time.


While equities still look good to ok they might not all do so if the CBs throw in the towel and these currencies are up 10-15%. There are signs of this happening with Russia moving bands yesterday and MAS allowing SGD to strengthen today.

We are also not blind to other catalysts out there to turn some of these acutely overextended trades around. QE we have discussed extensively but no one seems to think it will do much good for anything except asset prices which might give pause to the Beard, especially given what the theme song of the US house is likely to be post midterm elections. We even now have Bill Gross and Medley (allegedly) weighing in on the issue, But much more importantly Mr T has laid down a marker in Gold, with a landmark interview on Bloomberg.

All we need now is a call on EURUSD from Gisele for a full house.

With Ron Paul and his tea bag/party/Dachau re-enactment society/whatever cousins calling for action on China and less of the monetary easing Ben Bernanke is calling for it may not be the most politically prudent move for the Beard to print here if he wants to keep his job. Even some of those Southern Democrats and Freshwater Economists including Hoenig and Fisher on the FOMC are calling “no more”.

Watch this space. TMM are moving to more liquid positions and keeping an eye on well informed Asian CBs – something is up. If the walls start bleeding and we wake up at that last train stop in a carriage full of killer robots we are going to assume that our good macro trip of the last few months is definitively over courtesy of the Beard and/or some deal, however shoddy, on global imbalances.

Given yesterday's once again eye-watering inflation numbers out of the UK, TMM decided it was time for another look at UK policymaking, and it seems to us that the UK is undergoing a serious bout of Mervynflation. As far as TMM can tell, policymakers just haven't learned arguably the most important lesson of the crisis which is that groupthink amongst economic policymakers is very dangerous. And seeing the steady stream of calls for renewed monetary easing from such policymakers around the World post-Jackson Hole, gives TMM cause for concern. In particular, Adam Posen's recent eloquence making the case for a second round of QE in the UK. While Dr Posen can claim significant expertise with respect to the Japanese experience, TMM are now convinced that his line of argument ignores the most important considerations, those he clearly knows least about... THE UK. It is easy to see the attractiveness of the Depressionary view of the World post-crisis where deflationary forces caused by exceptionally large output gaps mean that the downside risk is very real and the evidence in the US is indeed worrying in this respect when we look at measures of resource utilisation. But this just isn't the case in the UK, as we will attempt to argue in this piece. TMM is concerned that this deflationary tunnel-vision by the Bank of England, and economic policymakers in general, as a result of the Jackson Hole consensus is causing a serious policy error in the UK.

Team BoE have been at pains to argue that the reason for the consistent upside surprises in UK inflation have been as a result of "one off factors" such as the large currency depreciation and the VAT hikes. Given we are now two years on from the collapse of Sterling, it is hard to argue that there is any remaining pass-through from this effect. As for the other "one off factor", TMM have attempted to strip out the VAT effects from core-CPI (see chart below: headline CPI - white, CPI ex-indirect tax - pink, core CPI - brown, core-CPI ex-VAT - green), and while this measure of inflation sits a lot lower than the headline, at 1.5%, it is still around the average level that core-CPI has been at since the BoE was given independent control of monetary policy. Since the emergence of China et al, a wedge between the headline and core-CPIs has opened up, something that policymakers regard as being a "one off", as energy and raw material prices are pushed higher. As regular readers will know, TMM believe this is unlikely to stop as the economies of these countries grow, and thus it is very hard to get sustained deflation in headline CPI. But the point here is that ex-everything-the-BoE-thinks-are-one-offs, inflation is pretty much where it has been for the past 13yrs. As some wags have commented in the past, inflation ex-everything is zero.... we're not fooled.

OK, so what about the relative picture? The below chart shows UK core-CPI (white line), UK core-CPI ex-VAT (yellow line), Eurozone core-HICP (green line) and US core-CPI (brown line). It is pretty clear that both US and EU core-CPI have been gradually trending lower, and to the lows of their historical ranges, but the UK measure is nowhere near the negative levels it fell to in 2000. As far as this chart goes, it is possible to construct a deflationary argument in the US & Eurozone, but laughable as far as the UK is concerned.

"Ah," you say, "but what about the output gap? That chart only tells you what has happened, not what is going to happen. Growth is going to be very slow, unemployment is going to rise when the public sector spending cuts start, and we will have a double dip". Well, the trouble with this argument is that the UK is not the US, the output gap is a lot smaller as unemployment didn't rise anything like as much as economists expected, and has begun to fall (see chart below -white line, inverted), while manufacturing capacity utilisation (yellow line) and the CBI's capacity utilisation survey (orange line) have both retraced a large amount of their fall and are either at or approaching the levels of the past 15yrs. As a wise colleague once said to TMM, the trouble with measuring the output gap is that you're trying to fit a line using past data that is going to be revised, using present data that will also be revised in order to predict where you think future potential output will be (that will also be revised). TMM is thus of the view that making policy based upon something so transient is somewhat short-sighted.

In terms of the public spending cuts, as Ben Broadbent (TMM's favourite UK economist) at GS keeps pointing out, the public sector job losses are equivalent to 0.4% negative job growth, while the private sector is adding jobs at a rate of 1.6%, which will comfortably offset the loss of those public sector jobs. A recent OECD study also finds that in the UK the fiscal multiplier is something like zero, plus or minus 0.1 (!). As we've pointed out before, the two periods of strongest growth in the past 30yrs were during periods of fiscal retrenchments... now, that may or may not be due to FX rate falls or monetary policy, but that is a subject for another day.

The other argument the BoE put forward is that wage growth is tepid. But this misses the point. Once inflation shows up in wages, it is too late... Anyone remember the wage-price spirals of the 1970s??? Today's wage data seems to suggest that the rate of pay increases (see chart below) is beginning to turn back up again...

...And Nominal GDP (chart below, white line) has reached a new peak, even as Real GDP (brown line) is still well-below its peak. The answer here is inflation, and as far as the guy on the street is concerned, the economy is nominal GDP - the money illusion is real (excuse the pun).

But back to the BoE... TMM have updated their UK Taylor Rule (see chart below) which is based upon the unemployment gap and consensus economic forecasts. The brown line is using straight core-CPI, while the purple line uses core-CPI adjusted for the VAT effects, and both suggest that policy is too loose, and that rates should be around 2%. To be talking about doing more QE when policy is already too loose seems somewhat loopy to TMM.

The extent to which the BoE have allowed inflation to rise and continue to set policy too loose has begun to have a material impact upon inflation expectations, and TMM are surprised that the BoE have allowed these to begin to de-anchor, something they put down to the economic groupthink of Jackson Hole. The Fed, for example, usually respond either with rhetoric or action when two of the following measures of inflation expectations begin to de-anchor: (i) professional forecasters, (ii) market-based and (iii) survey-based. Well, the charts below seem to suggest all of those have in the UK. Professional forecasters have raised their long-term inflation expectations from around 2% to 2.5% (chart below, blue dots):

The market-based measure implied by 5y5y fwd breakevens has settled into a higher range of 3-3.5% vs. pre-2007 range 2.5-3.1% (see chart below, white line), and have stayed high, even as the equivalent measures in the US (orange line) and EU (yellow line) have moved lower as deflation fears have grown:

And the BoE's own inflation expectations survey shows a clear de-anchoring:

TMM's question for the BoE is "At what point do you accept you have got this wrong?". While conspiracy theories have grown that this is all part of a grand plan to inflate and reduce the real debt burden for both households and the government, TMM think it is more to do with groupthink than anything sinister. The trouble is, we have no idea at what point the BoE will finally respond... 4% CPI? For the time being, both Sterling and Gilts have to be a sell on rallies given the inflation tail risk.

TMM was surprised to see that the renowned dove, Jenet Yellen, in her first speech as Fed Vice Chairperson chose to warn about the dangers of policy being too loose. As we noted last week, the QE2 mania has permeated many asset classes with anything from 350 Gigadollars to 1 Teradollar or even more. The question is, with these numbers flying around whether it is possible for there to be an upside surprise in terms of QE announced? TMM note that historically, the Fed have argued that they do not wish to be seen as monitizing the Federal debt, and as such, a ceiling at the level of net issuance is appropriate. Given that hard limit, TMM is beginning to wonder if QE2 the appropriate name. It certainly seems as if the trade is so crowded that the lifeboats have had to be ditched to make room. And that, all of a sudden, makes it look more like the Titantic...

...has an iceberg been spotted?

As has often been the case in the "macro is everything" world post-2008, correlation has been comically tight amongst thematic trades. Look no further than Fortescue, an Australian iron ore producer for an AUD proxy. Long term pricing for iron ore by most analysts worth their salt is 50% down from here which makes this all the more remarkable: if this company hits its numbers then iron ore demand has to go up a lot at at time when China is planning on reorienting its growth path to less fixed asset investment.

Similarly, those in the know aren't arguing about whether AUD is fair value but more just how many sigmas worth of deviation we are looking at here. TMM estimates range from 1.7 to 3. Hardly a great long term buy unless you really think the USD is going down the toilet, in which case there are better things to buy.

It is TMM's view that once again, people's risk models may not be picking up just how much risk they have on and how correlated their books may have become. Which means that those riding the QE2 might want to look at alternative transport or at least know where the lifeboats are.

As signs begin to materialise of a turn in the Dollar and Gold after Wednesday's TIPS-mania (even if it may only prove to be a temporary pause), TMM was amused to see their arch-enemy Voldemort lower the USDCNY fix by quite a chunk following their holiday. Masterful Realpolitik ahead of the G20 meetings. TMM was also amused to see Moody's floating the suggestion that they might upgrade China's sovereign rating which the FX market took as a reason for AUD and the likes to jump 25pips. Hmm... given that the evil capitalist running dog ratings agencies have usually been well-behind the curve on ratings, TMM struggle to believe that this is new news, but whatever... In terms of la guerra de la moneda, TMM are re-reading Nineteen-Eighty Four for guidance as to what happens next as they have noted eerie similarities between its perpetual protagonists of war, Eurasia, Eastasia and Oceania and current global FX policy.

As opposed to the Nobel committee which is clearly a bunch of New York Times editors moonlighting on a Swedish boondoggle. TMM applaud the awarding of the Nobel Peace prize to a Chinese dissident (certainly more deserving than the dissident in the White House). But we would like to propose that next year the Nobel Committee introduce a Nobel Currency Peace Prize. Malaysia and Australia being the obvious contenders. We would also suggest that it be retrospectively awarded to Japan for years 2008 and 2009, but then instantly rescinded after recent doping tests proved positive.

But back to the QE-hysteria... Mr Bullard put the cat amongst the pigeons by suggesting that QE is not a done deal, and that the economy hasn't slowed enough to make QE obvious. Now, while TMM expect (as does just about everyone else) that the Fed will definitely do QE2, whether there is 350 Gigabucks or 1 Terabuck priced into the market, it is clear that such a comment coming from the Fed member who was the first to argue for renewed QE a few months ago means that the Fed is unlikely to follow any shock and awe type approach. And that means that QE is overpriced, as far as TMM is concerned. Those who still own the best trades of the last month or two probably will need a stretcher to get them off the pitch at this point: Palladium and Silver are both down 4.5% or so and if April/May is anything to go by the cliff diving may have only just begun. TMM have learned the hard way that trying to hold this stuff all the way to the top and sell after the turn never works – better to take the money and run more often than not.

And finally, to today's random number generator... no, TMM is not talking about the Euromillions lottery, but the Non-Farm Payroll print. Why people continue to pay attention to such a statistically insignificant number continues to baffle TMM but, for the record, TMM's private payroll model (see chart below, model - orange line, official private payroll change -white line)is forecasting a zero private payroll gains. Against the Bloomberg consensus of +75k, that would be a disappointment (although, to caveat, TMM's model underestimated official payrolls for a good part of the last year). Good luck to us all.

Well, if TMM thought that the move in real rates, gold et al was overdone yesterday, this morning they find themselves even more surprised. 10yr Real rates took a 20bps dive yesterday, while breakevens widened and nominal yields fell 10bps. Some combination. We even read many reports of TIPS dealers receiving requests from accounts that have never traded TIPS before which we read as a classic mania-like/capitulatory signal. TMM remembers all those equity accounts selling EURUSD at the height of the Europanic, buying Libor-OIS spread wideners, as well as buying BP CDS at 1000bps. Receiving a message from an FX shag talking about real rates and TIPS yesterday afternoon comfortably fits with this hypothesis (unless of course this was an example of a macro-blog positive feedback loop).

But TMM can't help but wonder how much of the current market excitement is also due to "Bigfiguritis". A disease which is seeing outbreaks of almost pandemic proportions. Cases have been reported in Eur/usd with 1.4000, dow 11000, NDX 2000, USDKRW 1100, AAPL 300 and even Palladium at 600. The Goldbugs have just got over a case at 1300 and are in remission until 1500. Oh and whilst on Gold, we can't help notice that the move in gold has not been driven by ETF flows but more by miners removing their remaining hedges. All we can say is that there is less protection for the producers in the market than a Bay Area sex party in 1978. Let the band play on...

Bigfiguritis is highly infectious and historically was transmitted via whispering. However, modern means of communication have seen a surge in cases transmitted by the media via electronic methods. Bloomberg is a prime culprit.

Signs and symptoms - presents as irrational binary behavioural responses to normal curve distributed probabilities, accompanied by hysteria, fevers and agues. Extreme cases may elicit a rash of highly infectious parity party invitations. Symptoms can also present similarly to "St Vitus' Dance".

Treatment - Bigfiguritis in FX patients normally responds well to a simple dose of "WELL, TRY INVERTING THE PRICE AND TELL ME HOW YOU FEEL NOW". Recent studies in EUR/USD at 1.4000 have seen very good responses with follow ups of "SEE? IT'S JUST 0.714285714 - NOT SO CLEVER NOW HUH??" However, if there is no response it may be a case of the often fatal Parityitis, which does not respond to price inversion and is currently endemic in Australia. The only known treatment for Parityitis is removing the patient from the source of infection and palliative care. Bigfiguritis in other asset classes is harder to manage as reciprocals of stock indices and commodity prices are often rejected by the patient.

Complications - recovery from Bigfiguritis and Parityitis can be a long process with patients often suffering from a feeling of deep loss. A person may report feeling "sad" or "empty", may cry frequently and exhibit irritability. This should be managed with either "Don’t worry there will be another one along soon, I'm sure" or with "Well, we all thought it would get there, never mind". However, Bigfiguritis in the media or broker market presents no such ongoing complications with the patient swiftly forgetting and even denying they had ever suffered from it.

The Great Bigfiguritis of 1300:

So for today we will sit quietly - gowned, masked and gloved - trying our damnedest not to become infected as we hand out treatments.

TMM make no secret of the fact that they struggle with the current love-athon in bond markets which rests on the idea that rates will be held low until the year 3000 along with FOMC LLC's asset allocation switch out of paper & ink and into USTs. The price action across assets and, in particular, the Dollar & Treasuries are clearly indicative that the macro community has decided that *this* is "The Trade" for Q4. And it may well be, but the speed with which things have moved gives TMM grounds for caution. As TMM's good friend Mr Macro at Nomura is fond of saying, QE is designed to increase inflation expectations, so if there is an open-ended commitment to undertake further QE until inflation is sufficiently high (the Fed's unofficial core PCE target is ~1.75%, with the core CPI sitting about 0.5% higher than that), then buying 10yrs at 2.45% is going to produce a real return of something like 20bps. It just does not make sense.

"Ah", you say, "but that is the point, to get real rates as low as possible". Well, Team Easy B have certainly managed that, sending 5yr real rates negative and 10yr real rates to around 0.65% - not much higher than the above back-of-the-envelope calculation. In fact, since equity markets peaked in April, the 5yr real rate has fallen 63bp (see chart below, white line), the 10yr real rate has fallen 75bps (orange line) and the 5y5y forward real rate (i.e. the market's view of the long-run real rate of return, usual TIPS-related caveats apply) has fallen over 100bps. Following the line of argument that QE lowers real rates, we can see that when the Fed announced QE back in March 2009 the 10yr real rate moved by about 50bps, as did the 5y5y real rate. In recent weeks, as the market has moved to expect more QE, they have both moved about 57bps. Now, as QE is designed to increase inflation expectations and support growth, if the Fed is successful, one would expect the long-run real rate (which is essentially a measure of real trend growth) to mean-revert back towards the 2-2.5% range. Post-QE1, this did indeed happen, even as the spot-starting real yields fell, reflecting easy policy in the near-term but "normal" policy (if there exists such a thing), in the medium to long-term. Sure, it's possible that it stays low or moves even lower, reflecting Ben's bid, but the inflation expectations component of yields will have to move higher. On this metric, at least, it doesn't look like there is much room for nominal yields to rally much further.

So just how much QE is the market expecting? A number of academics have attempted to answer this question, but it's obviously pretty difficult and subjective to attribute just how much of market moves are due to QE announcements. In fact, many of these attempts are more propaganda pieces aimed at showing people just how well central banks did (read any BoE report on this for more details...!). Now TMM is unconvinced that QE operates through anything other than the "shock and awe" channel, which is policymakers' best weapon in the fight to reflate markets and animal spirits. Its use in March 2009 was clearly along this line, though the recent arguments from various Fed members have been more along the lines that the Fed will drip feed QE on a month by month basis. The trouble with this approach is that the market is a heroin addict and the effect of each subsequent $100bn monetary hit fades away and soon enough we will be back in the situation whereby the Fed is labeled "out of bullets". TMM does not think this argument is lost on the Fed, though the loss of the outstandingly savvy Don Kohn makes the former more likely.

But we digress. In TMM's view, one of the purest ways of working out the market's QE expectations is to look at the relationship between 12m T-Bills and excess reserves at Federal Reserve banks. Although not a perfect measure, under QE one would expect 12m bills to follow Fed excess reserves reasonably well as bank Treasury departments manage their short term cash balances. Certainly since the introduction of the 0-0.25% band for Fed Funds, this relationship has held well (see chart below, white line - 12m T-Bill yield, pink line - reserve balances). However, since the EMU crisis and the downturn in US economic data, this measure has diverged as expectations of further QE have grown, and is now consistent with the Fed's excess reserves expanding by ~$350bn to about $1.34tn.

Now, TMM did a brief survey of some of their macro mates yesterday, yielding the expectation that the Fed will announce an initial programme of about $300bn, which is reasonably close to this number and, along with the moves in real rates goes a long way to suggesting that QE is already priced in by markets. Of course, markets are only really vulnerable to turns when positioning is all one way. As we have mentioned before, getting positioning data in the rates market is very difficult because so much of it is OTC. But one metric, TMM like to use is the CFTC duration-adjusted non-commercial speculator net position as a fraction of overall open interest (see first chart below) in USTs and a similar metric for Eurodollar futures (see second chart below). While these only capture a fraction of speculative positioning in markets, they *do* capture a significant portion of its *trend-following* position by virtue of how the droids CTAs execute their trades. As can be seen below, these are both at levels not seen since early-2008. In the context of hedge funds managing, say, 70% of the money they were pre-crisis and employing half the leverage, their power is something like 35% of what it was pre-crisis, so on this risk-adjusted basis, positioning is exceptionally long.

The point here is that anything less than "shock and awe" QE is priced in, and *at best* bonds stay where they are, or at worst, a 2003-like reflationary-driven convexity sell-off is on its way.

TMM are back from the weekend and for those of us who look at all things EM, and particularly Asia, there isn't much to say except that we are seeing more of the same. The Hot Money Shuffle (unrelated to a similar-sounding Rolling Stones song) is in full effect: "Fund Flows YTD flat to China? Get me a stick of HSCEI. Indonesia busting through all time highs? Call in the droids CTAs."

The question is "Where does it all end?". Even the great and good of investing like Jeremy Grantham are calling for an EM bubble and to date we're well on track. All the hallmarks of a great bubble in Southeast Asia are here: hard to borrow stocks, poor-ish liquidity in futures for some markets and valuations which are getting toppy, but as it's hard to call a turn there are few sellers apart from insiders. All the more, TMM are having a hard time identifying the fatal flaw here - as much as many of us are natural contrarians, it's never a good idea to step in front of a bus if you're nowhere near the bus stop. Readers are welcome to suggest how this all ends out here because we are out of ideas.

Instead, we leave you with yet another compelling bull market case for Asia, this time in Airlines. TMM is not alone in complaining about airlines in the US and Europe, and after seeing this video of a Cebu Air flight safety demo we feel entirely justified in doing so. If you look on Bloomberg, the company is pending listing, leading some to the logical conclusion that this is a killer viral marketing campaign. Despite TMM's fairly bullish views on oil and particularly Tapis its hard not to buy in - airlines are 80% macro risks and 20% marketing and these guys seem to have the latter down pat: Which is more than we can say for JetBlue.

And finally, to the title of our post... TMM has to hand it to the French, handing Jerome Kervial a EUR 4.9bn fine and five years in jail. He must be thinking to himself "Sacre Bleu! I should've waited to write my book until after declaring bankruptcy". We are referring Mr Brown's Gold trading to the same court hoping for a similar punishment.